Chief executive's statement - source: annual report 2004-05

This was a year of transition for Postcomm: we moved decisively towards introducing full market opening and a new set of price controls to come into effect next year; and responded to a changing Royal Mail which has begun to alter its approach to competition and tackle service quality with a renewed vigour.

The Commission itself is in transition: two out of the seven commissioners were replaced during the year, and only three of the current team have been in place for more than eighteen months. New skills have been brought to the Commission and the executive team to reflect the changing phases of development of Postcomm and of the UK postal market.

Opening the mail market to competition

The most significant decision we made was to bring forward full market opening by 15 months (with effect from 1 January 2006).  This should have fundamental long-term implications for the development of the UK postal market – the first in Europe to be fully liberalised with an effective regulatory regime.

The decision was not made lightly. Our initial proposal in September 2004 followed careful consideration of the impact a faster opening of the market would have on Royal Mail’s ability to finance its universal service obligations. The evidence was compelling: already in 2003-04, before the efficiencies from its Renewal Plan had come through, the company earned a 6% operating margin (£348 million) on revenue from its price-controlled letters business.

The first stage of postal competition, which started in April 2003, had made only a tiny impact on Royal Mail’s monopoly. The company still had a market share of more than 99%, and very few customers had an effective choice of operator. Royal Mail welcomed the proposal to speed up market liberalisation, reflecting an encouraging change of culture within the company. We confirmed the proposal in February 2005, following further consultation which was decisively in favour of ending the monopoly on this timetable.

Making the decision to speed up liberalisation was one thing: putting all the mechanisms in place to make sure that a multi-operator market works in practice is quite another.

An intensive work programme was put in place to develop a new licensing framework to encourage market entry while providing sufficient safeguards to protect customers’ interests. The Commission believes this requires a code of practice to ensure that all mail companies cooperate on operational issues such as the forwarding of mail and handling mail that is returned to sender, and a separate code to safeguard the integrity of mail. We also started work on reviewing the management and control of the postcode address file (PAF), the Royal Mail database that lists every postal address in the UK, and which is licensed to many other businesses.

Universal service

Postcomm’s first duty is to ensure the provision of a universal postal service. In June 2004, we defined the services that must be provided by Royal Mail as the universal postal service for users of non-bulk services. The decision followed a lengthy review during which customers were asked, for the first time, what they wanted from the universal service. We also took a decision on the generic need for a universal service for bulk mailers, and consulted on a proposal for a reduction in the extent to which bulk services have to be regarded as universal services. This represents a significant deregulation and removal of constraints from Royal Mail. The company wants us to go further still, but we are determined to ensure that everyone continues to benefit from the ‘one price goes anywhere’ universal service.

Service quality

As the year began, Royal Mail was in serious difficulty on service quality. In the previous year, it had failed all 15 of its service targets – a lamentable performance which was repeated in the first quarter of this year. Performance since then has improved significantly, with a welcome change in the approach to quality at the most senior levels in Royal Mail. There is still more work to be done to ensure that all parts of the country benefit from the renewed focus on quality.

After a thorough investigation into the reasons underlying the service failures in the previous year, in March 2005 we announced a series of measures which were, or were about to be, put in place. Licence conditions introduced by Postcomm in the existing price control ensured that significant compensation was paid to customers: £43 million in direct compensation, and £17 million out of Royal Mail’s revenues for 2004-05. Royal Mail also gave undertakings to improve its quality control procedures and to extend its credit terms for business customers from 21 to 30 days, facilitating any compensation entitlements for 2005-06.

Promoting competition

In March 2005 we published a report setting out what more we would do to stimulate a competitive market, tackling the barriers to entry previously identified. We decided to favour the inclusion of access in Royal Mail’s next price control; to monitor Royal Mail closely for any signs of anti-competitive behaviour; to provide more information to customers about the choices available to them; and to continue to pursue with HM Treasury the possibility of a reduced rate of VAT to be applied to all licensed postal operators. We recommended that all historical privileges should be removed from Royal Mail, apart from the exemption from parking restrictions when collecting mail from postboxes.

In January 2005, we concluded that Royal Mail had contravened conditions in its licence designed to facilitate competition. The company gave undertakings to Postcomm on the way it will in future conduct any promotional offers and special deals with non-standard terms. We are continuing to investigate further complaints from competitors who feel their business is being threatened by unfair actions by Royal Mail, including a substantial investigation into Royal Mail’s offer of zonal prices for access.

Postcomm welcomed the establishment in early 2005 of the Mail Competition Forum. This is a group of licensed operators who provide valuable advice on market developments and the impact of regulation.

New price and service quality controls

For as long as Royal Mail retains a dominant position in the postal market and many customers have no effective choice of operator, it will be necessary to protect Royal Mail’s customers through controls on its prices and service quality. The current controls are due to expire in April 2006, and in September 2004 we set out our initial thinking on the controls that should replace them.  We envisage a framework which will allow the degree of regulation over Royal Mail to be relaxed progressively as competition develops.

Consultation on our framework proposals continued until after the end of the reporting year (with publication of our full initial proposals on 1 June 2005). During the consultation, we conducted a thorough review of the costs to Royal Mail of providing its regulated activities, including the universal service.  We also took account of Royal Mail’s need to make pension fund deficit contributions, to invest in new capital equipment and to finance its operations.

It is clear that the company has significantly outperformed the current price control and is in good financial health. This makes it possible to set a new control which will allow customers to share in Royal Mail’s much higher efficiencies, which they have not done up to now. This can happen while still allowing Royal Mail the freedom to make an adequate profit on its regulatory activities, earn further returns if it continues to make significant efficiency improvements, and pay down progressively its pension deficit.

Our proposals seek to freeze Royal Mail’s average domestic prices from 2006-10, introduce service quality targets more suited to customers’ needs and create the conditions that will enable new operators to establish themselves successfully in the mail market.  Consultations on these proposals are continuing.

Separately, we also consulted on Royal Mail’s proposals to restructure its prices so that they would vary by size and format, as well as by weight, in order to align prices more closely with costs. Our first consultation, in April 2004, drew around 10,000 responses. Towards the end of the period Royal Mail presented a revised set of proposals which addressed the issues which had caused us (and customers) particular concern. On 5 April 2005 we presented our provisional conclusions that we were minded to accept the revised proposals, subject to any new evidence that may come during the current consultation period.

Mail integrity

Customers will only have confidence in the developing market if they can be assured that their mail is safe in the hands of whichever operator is handling it. Allegations were made during the course of the year that Royal Mail was failing in some of its procedures for recruiting, vetting and training staff and for providing security for mail within the postal pipeline. Postcomm started an investigation to determine whether Royal Mail has used all reasonable endeavours to apply its mail protection procedures.  This investigation is still underway.

In January 2005, Postcomm successfully brought its first prosecution for mail dumping, following investigation into the activities of a casual employee working for a licensed mail delivery firm. Looking forward, we have proposed that all licensed operators should meet common standards to safeguard the mail in their charge from theft, damage or interference. We began consultations in March 2005 on a code of practice on mail integrity which, when agreed, may be backed by a licence condition applied to all operators.

Post Office network

Postcomm began a review of the Post Office urban reinvention programme, to evaluate the short- and medium-term economic and social effects on domestic and business customers, sub-postmasters and Post Office Ltd. Conclusions will be published in the Post Office Network Annual Report which helps inform the Secretary of State for Trade and Industry and other interested parties.

Looking forward

This report can only be a summary of progress achieved across some of the more high profile parts of our activity. My first four months in Postcomm have made it abundantly clear that I have joined at a critical time in the development of the UK postal market. It is also clear that we have a lot to do in a short space of time if we are to ensure that market opening and the processes that accompany it really do help us to achieve our vision, and in particular that all customers will benefit. The year ahead will be just as busy, and just as critical to the long-term health of the market and its participants.

Sarah Chambers